Market investors gain even when they miss out on bumper IPO allotments

A surge in household savings directed into the stock market, both directly and through mutual funds, has lifted stock prices and price-to-earning ratios, often to unrealistic levels.

The only way to keep stock prices tethered to realistic levels, as more and more money enters the market, is for the listed universe of companies to grow. IPOs serve this purpose, and contribute to keeping stock prices saner than they otherwise would be. Everyone gains, including those who did not get to benefit from the listing gains on some fresh public offerings.

Crisil has been projecting a massive rise in the financialization of Indian households. This might seem to be at odds with the RBI Annual Report’s finding of a decrease in the net financial savings of households. In reality, there is no contradiction. Net financial savings have come down because of an increase in liabilities. Household financial liabilities went up from 3.8% of GDP in 2021-22 to 5.8% of GDP in 2022-23. At the same time, there has been a massive inflow of savings into mutual funds and other managed pools of savings, such as insurance, retirement plans, portfolio management schemes and alternate investment funds.

Certain sections do invest in financial assets with borrowed money, but financial assets have declined as a share of GDP between 2021-22 and 2022-23: from 11.1% to 10.9%, meaning, in conjunction with the rise in financial liabilities, means that it is not borrowed funds that are, on a net basis, bloating the managed pools of saving being deployed in the capital markets.

Quoting a Goldman Sachs report, the Business Standard reported that, for a second year in a row, mutual funds are poised to pour at least ₹1.5 trillion into the stock market. In 2022, such deployment had been ₹1.8 trillion.

Crisil in a report, The Big Shift in Financialisation, pointed to a rise in gross managed assets rising from 41% of GDP to 57% of GDP over the five years to 2022. It revealed the biggest category of managed assets was life insurance, accounting for 38%, while mutual funds accounted for 28%. Managed funds invest in shares and bonds, of course.

This inflow of domestic savings into the stock market has kept the markets buoyant, even as foreign portfolio investors dumped Indian stocks between August and November. Buoyant markets incentivize further inflows into the market. 

With the prospects of additional rate hikes by the US Federal Reserve receding, and despite the absence of immediate rate cuts, the US economy seems set for a soft landing. European economies are geared to follow suit. In India, more portfolio flows are likely, on top of the net inflows of $21.4 billion in 2023 so far.

The price-to-earnings ratio for the Sensex is already in the mid-twenties, and the price-to-book ratio has risen past 3.4. True, Indian markets have historically seen higher PE ratios than say, the Chinese market, but there is no gainsaying that high price-earnings multiples indicate speculative hype, which could be deflated by some adverse turn of events, leading to a sharp correction and losses for investors under-prepared for such vagaries of the market.

The only check on a frothy market without control of capital inflows is a steady increase in the supply of shares, in which to deploy these funds. And that is what is accomplished by a steady stream of IPOs.

IPOs tend to be analysed in terms of individual success in an issue getting fully subscribed. Right pricing and transparent, credible information about the prospects of the company would determine the success of such offerings. Collectively, their role in restraining overvaluation of share prices and, thereby, reducing the fragility of stock market bounces, also need to be taken into account.